3 Stocks Poised to Plunge After Earnings

by Jamie Dlugosch | November 15, 2011 7:30 am

The market and economy are incapable of sustaining premium or momentum-based valuations. Sure, companies are still growing profits at a double-digit clip, but valuations and Wall Street estimates are such that the bar has been raised too high.

It can pay to sell now or to short stocks with high valuations that might disappoint. Here are three companies reporting results this week that are likely to drop if earnings fail to impress:

Target (NYSE:TGT[1])

One doesn’t necessarily think of Target as a momentum stock, but the shares are fairly toppy and vulnerable to a hit.

Target reports results on Wednesday. Over the last two quarters, the company has beaten analyst expectations by a wide margin. That performance helped push the stock up 14% since the end of June, compared to a 5% loss for the S&P 500.

The company is expected to make $4.23 a share for its year ending Jan. 31. That profit is expected to grow by a meager 3% to $4.35 a share in the next fiscal year.

It is that anemic growth expectation that makes Target a rich stock at the moment. At current prices, the shares trade for 12.5 times current fiscal year estimated earnings. With an economy running out of steam, an earnings miss in the current period or lower-than-expected guidance will result in shares giving up some of that premium value.

I would sell shares in advance of the report, and my expectation is for a 5% or more decline in stock value after the report.

Salesforce.com (NYSE:CRM[2])

One of the monster momentum stories of the last year or two is cloud computing. Companies with a credible product in the space have huge valuations. That is certainly the case of Salesforce.com. As of yet, we are still talking about the potential of the company. At some point investors will demand more.

That time may be this week, when Salesforce.com reports earnings on Thursday. Citibank is out with an upgrade of the stock in advance of the report. I would be cautious.

Analysts are looking for a profit of 31 cents per share for the quarter. In the last four quarters, results have been simply OK. The company has met or beaten by a penny in three of the last four quarters. That is not the kind of result that momentum investors look for.

For the full year ending Jan. 31, the company is expected to make $1.30. That number increases by 37% to $1.78 a share in the next fiscal year. Citi seems to think that estimates in the next year have room to improve. The analyst there believes the company can do better than currently expected.

It better do just that. At current prices, shares of Salesforce trade for more than 100 times current-year estimates. Given how the company has simply matched estimates in the last year, don’t hold your breath for big improvements in guidance for 2013. If the guidance disappoints, shares are likely to trade below $100 after the report.

I would be short this stock in advance of earnings.

Sears (NASDAQ:SHLD[3])

Sears has been a great example of financial engineering at its finest. Hedge fund manager Eddie Lampert has managed to create value where it could be argued that none exists. Sears has been irrelevant for some time, yet the company has a market capitalization of more than $7 billion.

In the last two quarters, Sears has lost money at an even greater clip than what Wall Street was expecting. When it reports results on Thursday, the average estimate is for the company to lose $2.29 a share.

What on earth are investors thinking owning this stock?

For the full year ending Jan. 31, Sears is expected to lose $1.78 per share. Sure the loss is expected to shrink to $1.04 per share in the subsequent year, but is that enough to justify the $7 billion market cap today?

The market is in no mood for such hopeful things. If the result for the current period is worse than expected, that market cap is likely to take a bigger hit. I would be short this stock heading into earnings on the simple basis that profits and profit growth are a long way down the road.